Price Is Compressed Knowledge A Rate-Distortion Account of Markets, Bubbles, Crashes, and the Limits of Collective Intelligence An Application of Adaptive Compression Advantage Theory (ACAT)

Hayek (1945) argued that prices aggregate dispersed information. The Efficient Market Hypothesis (Fama, 1970) formalized this as the claim that prices reflect all available information. Neither framework specifies the mechanism by which information enters prices or the conditions under which this mechanism fails. This paper applies the Adaptive Compression Advantage Theory (ACAT; Murata, 2026) to demonstrate that a market price is a collectively compressed gist—the output of many individual compression functions operating on different information subsets and aggregated through the trading mechanism. We derive that: (1) market efficiency is determined by the α(d) diversity of market participants, not by aggregate information availability; (2) bubbles are collective overfitting—the market’s generative model compresses noise as if it were signal; (3) crashes are collective prediction-error cascades—simultaneous model failures across participants producing positive-feedback selling; (4) active managers underperform indices because the market’s collective α exceeds any individual’s; and (5) the specific conditions under which markets fail to compress information correctly are predictable from the α(d) distribution of participants. Nine testable predictions are generated, several with direct implications for market design and regulation. Keywords: markets, price formation, efficient market hypothesis, bubbles, crashes, compression, rate-distortion theory, ACAT, collective intelligence, Hayek, behavioral finance, active management, market microstructure, volatility